Takahide Kiuchi's View - Insight into World Economic Trends :
Insight into Economic Trends: Can Foreign Exchange Intervention Halt the Yen’s Depreciation?
Oct. 14, 2022
On September 22, the Japanese government embarked on a foreign exchange intervention that involved buying yen and selling dollars. This is the first time in 24 years since June 1998 that the government has gone through with a yen-buying intervention. This time around, Japan has made an independent intervention, with the European and U.S. central banks opting not to make such a move. In addition, the scale of this intervention is 2.8 trillion yen, making it the largest dollar-selling, yen-buying foreign exchange intervention to date.
Even after this foreign exchange intervention, the yen will continue to depreciate
On the day this foreign exchange intervention was announced, the Bank of Japan decided at a regular Monetary Policy Meaning to maintain its current monetary policies. Furthermore, at a press conference following that meeting, the Governor of the Bank of Japan once again flatly denied any possibility that the Bank would raise interest rates or make any other policy revisions, and with that, the yen abruptly depreciated from the previous day’s level of 143 yen to the dollar to approach 146 yen per dollar. It was at this time that the government chose to undertake its foreign exchange intervention.
Immediately after the intervention, the yen temporarily saw a substantial rise to the level of 140 yen to the dollar. However, as it became apparent that central banks overseas were not embarking on their own interventions, expectations for the efficacy of this intervention waned, and so the yen reversed course back on a depreciation track. In the overseas market that same day, the yen got pushed back to the level of 143 yen to the dollar. Then on October 12, nearly three weeks later, it hit 146 yen per dollar, surpassing the level at the time of the intervention, and the yen has continued to depreciate even further still.
It's expected that such foreign exchange interventions will also be carried out periodically going forward. However, these interventions typically have the greatest effect the first time, and they gradually become less effective thereafter.
Incidentally, when advanced nations implement a foreign exchange intervention, they’re required to obtain prior consent from other countries, and from the U.S. in particular. Any foreign exchange intervention that would interfere with market mechanisms is fundamentally undesirable, and thus advanced nations regard such interventions as something to be done only in exceptional cases, since they can cause the exchange market to fluctuate excessively from speculative activities.
At a press conference held on October 11, Finance Minister Shunichi Suzuki told reporters that “we have gained a certain extent of understanding from the U.S. authorities towards our latest intervention.” This ambiguous phrasing would seem to indicate that the U.S. has reluctantly accepted Japan’s foreign exchange intervention but isn’t actively supporting it. For this reason, it seems unlikely that the U.S. will declare its support for Japan’s intervention down the road and thereby boost its effects. It’s also conceivable that Japan was asked to make such foreign exchange interventions only under certain conditions, e.g., if the exchange market is fluctuating dramatically.
A yen-buying independent intervention has limited effects and merely buys time
Unlike coordinated measures taken with various other countries, Japan’s independent intervention—and, moreover, an intervention that involves buying yen rather than selling yen—arguably has limited effectiveness in light of past experience. With a yen-selling intervention, the government can procure yen as funds for intervention with almost no restrictions, but in the case of a yen-buying intervention that involves selling foreign currencies, the value of foreign currency reserves owned by the government is the maximum amount of funding for intervention that can be obtained. The balance of foreign reserves held as of August 31 this year stood at $1.292 trillion. Insofar as there’s a limit to the intervention funding, the effects of that intervention will in a sense be readily visible in the market.
Plus, given this upper limit, the per-instance scale of a yen-buying intervention compared to a yen-selling intervention would also conceivably tend to be smaller. Between 1997 and 1998, the yen was sold against the backdrop of domestic insecurities over banking, and when the government embarked on a dollar-selling, yen-buying intervention, the highest single-day scale recorded came on April 10, 1998, at 2.6 trillion yen. However, the value of the interventions on other days never amounted to one trillion yen per day.
According to a survey by the Bank for International Settlements (BIS), as of April 2019, the average trading volume per business day for Japan’s foreign exchange market came out to $375.5 billion. If we supposed that the daily value of the intervention were one trillion yen, that would only be less than 2% of the daily trading volume in Japan’s foreign exchange market. In addition, the balance of foreign reserves is only 3.4 days’ worth of the daily trading volume on Japan’s foreign exchange market. When we consider the foregoing, the reality is that it will be very difficult to stop the yen’s depreciation with this independent yen-buying intervention.
What would likely put the brakes on the depreciation of the yen is if there were some change in the U.S. Federal Reserve Board’s (FRB) stance toward raising interest rates. With the FRB continuing to enact substantial rate hikes, signs of economic slowdown may lead to growing expectations that the FRB will explicitly slow the pace of its rate hikes as early as the end of the year or the beginning of next year. If that happens, U.S. long-term interest rates would no longer be on the rise, and the yen’s depreciation could also be expected to come to a halt.
The Japanese government’s foreign exchange intervention could probably be regarded as simply buying time, as it were, until that happens. That said, in the interim, even with repeated foreign currency interventions the yen would continue to depreciate, perhaps even reaching the level of 150 yen to the dollar.
The trilemma of international finance may lead many countries to sacrifice their monetary policy autonomy
There’s a well-known theory called the trilemma of international finance. The theory states that it’s impossible to simultaneously achieve (1) free international capital flows, (2) exchange rate stability, and (3) monetary policy independence. Currently, countries everywhere are feeling the pain of high prices, and so they strongly desire to have exchange rate stability, to avoid a depreciation of their currencies that could keep prices high for longer. In that case, they must give up on either free international capital flows or an independent monetary policy.
While the FRB has raised interest rates by a substantial 0.75% three times in a row, the European Central Bank (ECB) and other central banks have also made significant rate hikes of 0.75%, to avoid falling behind and letting their currencies depreciate. When expressed in terms of the trilemma of international finance, this move can be said to sacrifice monetary policy independence in favor of exchange rate stability.
Although economic conditions vary from country to country, and the Eurozone’s economy is comparatively weaker than, say, that of the U.S., the ECB is choosing to follow the dramatic rate hikes made by the FRB even at the expense of the domestic economy, prioritizing the need to maintain exchange rate stability.
The fact that countries are thus competing over massive rate hikes in order to give the greatest priority to exchange rate stability could conceivably deal a major blow to the global economy.
Japan aims to ensure exchange rate stability through intervention
One country that hasn’t jumped on board this trend is Japan. Among all the major countries of the world, Japan is the only one to have maintained a negative interest rate policy. The Bank of Japan has explained that this policy is in line with domestic economic and price conditions. Assuming that’s true, it would mean that Japan hasn’t lost its monetary policy independence. If the Japanese government is seeking to ensure exchange rate stability amid such circumstances, it will be forced to abandon free capital flows among the aspects of the trilemma of international finance.
It’s inconceivable that Japan, an advanced nation, would adopt strict capital regulations restricting free capital mobility. However, while foreign exchange interventions are not capital regulations, they do involve a direct influence by the authorities on free market transactions, and as such they can be considered similar to measures that restrict free capital flows to a certain extent.
And yet foreign exchange interventions are not as strong a policy measure as capital regulations are, which means that stabilizing exchange rates will have limited effects as well. To enhance the effects of a foreign exchange intervention by even a modicum, the government would likely have to enact—at the same time—a monetary policy that factors in exchange rate stability to some extent. This would mean restricting monetary policy independence somewhat, among the elements of the trilemma of international finance. However, implementing that sort of policy mix will probably only become possible after the Bank of Japan appoints a new Governor in April of next year.
Other than buying time with foreign exchange interventions until the FRB changes its rate hike stance, the Japanese government probably has no options for the time being.